With well over $1 trillion in assets, both institutional and retail investors continue to flock to exchange traded vehicles as a way to build portfolios. Not only do these funds offer low costs and intraday tradability, but they also continue to make more corners of the market and alternative asset classes available to everyone [see also The Cheapest ETF for Every Investment Objective].
Exchange traded vehicles include the high-yielding world of master limited partnerships (MLPs). These investments offer unique tax structures. Though the funds were once reserved for rich and high net worth investors, due to the ETF boom there are plenty of ways for Regular Joes to get MLP exposure.
While once a quirky asset class reserved for the wealthy, MLPs have made it to the mainstream. The main reason for this is because investors have clamored for the security type as interest rates continue to rest at historic lows. Based on their corporate structure, MLPs pass on the bulk of their revenue to investors via big distributions; this is similar to real estate investment trusts (REITS). Unit holders—which is MLP speak for shareholders–are rewarded with 6-7% average dividend yields and some other tax advantages [see MLP ETFs Battle for Inflows: AMLP vs. AMJ].
The other reason for their growing popularity is because the bulk of MLPs own and operate the vast energy infrastructure crisscrossing North America. All across the country, various pipelines, petroleum storage tanks and switching terminals help move traditional energy from the wellhead to processing facilities for use. These infrastructure and pipeline companies’ profits are based on the volume of oil or gas that flows through their pipes, not on what that liquid is worth. Many come with regulated fee amounts with inflation adjustments, as well as “take or pay” contracts, which require users to pay regardless of whether the capacity is used. This allows investors to profit from the long-term trend of increasing energy demand, while providing a backstop against price swings.
However, while MLPs provide hefty income, they do come with some special considerations. Because MLPs distribute not only dividends but also write-offs for their asset depreciation, instead of receiving a standard 1099 form, investors can expect a K-1 statement in the mail. While K-1s aren’t too complicated, it does add another layer of frustration come tax time. By going the ETF route, investors are able to avoid these tax headaches [see also How To Find The Best MLP ETF].
MLP ETFs and ETNs: What’s the Difference?
While choosing to get your MLP exposure via an exchange traded product may seem like a no-brainer, choosing exactly how to get that portfolio weighting requires some thought. This is because both ETFs and their cousins, exchange traded notes (ETNs), offer several distinct advantages and disadvantages.
Because of legislation forbidding open-end funds and ETFs–like the $6.2 billion ALPS Alerian MLP ETF (AMLP, A)–from owning more than 25% of their portfolio in MLPs, many are structured as C-corporations. Essentially, that means the fund has to pay corporate taxes, which can be a major drag on performance in booming years. Those taxes are often reflected in the fund’s expense ratio. For example, AMLP charges 0.85% to manage the fund plus over 4% in other expenses [see Energy Bull ETFdb Portfolio].
By contrast, an ETN–like the JPMorgan Alerian MLP Index ETN (AMJ, B)–doesn’t have to hold the securities it tracks. This allows the fund to almost perfectly mimic its underlying index. However, in exchange for this, investors are subject to a certain level of counterparty risk. ETNs are senior, unsecured and unsubordinated debt instruments of an issuing financial company, so investors are taking on the credit risk of their issuer. Ask any investor in Lehman Brothers’ three ETNs what happens when that risk goes bad.
Not All MLP ETPs Deliver Stellar Yields
Though one of the biggest appeals of MLPs is their yields, there is a very broad range when it comes to those dividend payments. For example, the Barclays ETN+ Select MLP ETN (ATMP, n/a) currently yields 3.99%, while the Yorkville High Income MLP ETF (YMLP, A) yields a staggering 8.8%. The wide variability in yield stems from different segments of the MLP universe that these funds track. Pipeline owners tend to pay less in distributions than say a refining or shipping company using the MLP tax structure.
For those looking for dividends, here are the top five yield funds.
|YMLP||Yorkville High Income MLP ETF||8.8%|
|MLPY||Morgan Stanley Cushing MLP Hi Income ETN||7.15%|
|MLPA||Global X MLP ETF||5.6%|
|AMU||UBS E-TRACS Alerian MLP Index ETN||4.8%|
|MLPN||Credit Suisse Cushing 30 MLP Index ETN||4.68%|
The Bottom Line
For investors, it’s easy to see why master limited partnerships should be part of their portfolios; the funds’ high dividend yields are a welcome benefit in this age of low interest rates. Whether through an ETF or ETN, the exchange traded product boom has made it easy for regular retail investors to tap the complex asset class. Investors just need to weigh the pros and cons of the two structures to determine which is right for them.
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Disclosure: No positions at time of writing.